Office Depot Inc. (ODP) admitted Wednesday that a material weakness in its internal controls failed to prevent or discover the improper tax accounting that led to a restatement of its 2010 fiscal-year results.

The beleaguered office-products chain announced the restatement last week and filed its restated financial reports with the Securities Exchange Commission on Wednesday.

Office Depot had tried to carry back certain net operating losses from prior periods to receive an $80 million tax benefit last year, but the Internal Revenue Service denied the claim. The IRS denial caused Office Depot to reverse $33.3 million in net earnings it had reported for last year to a net loss of $46.2 million, and the company also removed from its books a current tax receivable of $63 million that it had hoped to use to bolster results for the current fiscal year.

Chief Financial Officer Mike Newman said in a conference call last week that he is "sick" about the mistake the company and its tax advisers made in applying for the tax credit, and called it his responsibility that the company failed to recognize the other tax rules the IRS said superseded the ones Office Depot was using.

In the future, Office Depot said it will "increase the level of review and validation work performed by management and third-party tax professionals" when preparing its provision for income taxes, as well as "require the involvement of two third-party subject matter experts for material and complex tax transactions."

The company believes "these remediation actions will represent significant improvements," it said, and it expects to complete testing on the new measures this year to determine if it has successfully remediated the material weakness. Additional measures may be required, it noted.

Office Depot has struggled in recent years, as the recession exacerbated the glut of stores in an office-supply arena where Staples Inc. (SPLS) dominates and third-largest player OfficeMax Inc. (OMX) has corrected past problems to present a more formidable challenge to Office Depot in the race for second place.

Sales at Office Depot have fell 25% from a 2007 peak through last year, and its 2010 revenue was barely above 2002 levels. It settled charges with the SEC last year related to the violation of fair-disclosure rules its former chief executive and CFO, who helped analysts temper their high expectations for the company a few years ago. It is currently looking for a permanent CEO, and has recently settled charges of improper pricing under certain state and local government contracts, pricing issues that appear to be the root of a new investigation by the Department of Justice that Office Depot announced in February.

Shares of Office Depot were recently off 1.8% at $4.28 a share; the stock has almost halved over the course of the past year. Meanwhile, despite posting annual sales last year that were more than $4 billion less than Office Depot, OfficeMax is only 18% lower than a year ago and, at about $1.17 billion, its market capitalization is now nearly the equal of its larger rival. Staples, whose shares are off roughly 15% over the last 52 weeks, has a market cap above $14.7 billion.

-By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; maxwell.murphy@dowjones.com
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